Chapter 5 Financial Markets and Institutions

1. Chapter 5 Financial Markets and Institutions

2. Role of the financial market : allocate scarce resources (capital) from savers (suppliers) to investors (users). • Suppliers: individuals and institutions with excess funds. • Users or demanders: individuals and institutions who need to raise funds to finance their investment opportunities

3. I. Financial Markets • Financial Market: is market place for selling financial securities: stocks, bonds and derivatives. • A security is a piece of paper that represents the investor’s rights to certain prospects or property and the conditions under which he or she may exercise those rights. • Stock or share represents ownership right in the corporation • Bond is a debt instrument issued by corporations who borrow money. • Derivative: is a security that derives its value from the value of another security (offers a return based on the return of some other underlying asset).

4. Example of Derivatives: • Stock Options: get their values from the value of a stock • Call option: gives the holder the right to buy a stock for a given price ( exercise price) prior to a certain date (maturity). • Put option ; gives the holder the right to sell a stock for a given price (exercise price) prior to a certain date (maturity).

5. Types of Financial Markets: • Spot vs. futures market: • Spot Market: assets are delivered “immediately”. • Futures markets: participants agree to today to buy or sell an asset at some future date. • Money vs. capital markets • Money market: short term financial assets are traded • Capital market: long-term financial assets are traded. • Primary vs. secondary market: • Primary market: market where financial securities are sold for the first time. • Secondary market: market for previously owned financial assets.

6. Financial Institutions • Commercial banks • Investment banks • Mutual savings banks • Credit unions • Pension funds • Life insurance companies • Mutual funds

7. Stock Market • Auction market vs. Dealer market (Exchanges vs. OTC) NYSE vs. NASDAQ Differences are narrowing

8. Stock market transactions • Google decides to issue additional stock with the assistance of its investment bank. An investor purchases some of the newly issued shares. Is this a primary market transaction or a secondary market transaction? • What if instead an investor buys existing shares of Google stock in the open market-is this a primary or secondary market transaction?

9. What is an IPO? • An initial public offering (IPO) is where a company issues stock in the public market for the first time. • “Going public” enables a company’s owners to raise capital from a wide variety of outside investors. Once issued, te stock trades in the secondary market. • Public companies are subject to additional regulations and reporting requirements.

10. Where can you find a stock quote, and what does one look like? • Stock quotes can be found in a variety of print sources (wall street Journal or the local newspaper) and online sources (Yhoo!Finance, CNNMoney, or MSN Money Central).

11. Efficient Market Hypothesis • Securities are normally in equilibriumand are “fairly priced”. • Investors cannot “beat the market” except through good luck or better information. • Level of market efficiency • Weak-form efficiency • Semi-strong-form efficiency • Strong-form efficiency

12. Weak-form efficiency: can’t profit by looking at past trends. • Semi-strong form: all publicly available information is reflected in stock prices. • Strong form: all information, even inside information, is embedded in stock prices.

13. Empirical studies suggest the stock market is: • Highly efficient in the weak form. • Reasonably efficient in the semi-strong form. • Not efficient in the strong from. Insiders have made abnormal (and sometimes illegal) profits.